AAPL: Pac Crest Cuts iPad View on Tablet Treands (Update)

By Tiernan Ray

Shares of Apple (AAPL) are down $8.19, or 1.8%, at $452.95, as Pacific Crest’s Andy Hargreaves reiterates a Sector Perform rating on the shares, warning that the company will likely miss expectations for the March-ending fiscal Q2 when it reports in April, and probably miss estimates for the June-quarter outlook, largely because of a lower outlook for the iPad.

Hargreaves cut his Q2 estimate to $41.1 billion and $9.60 per share in net profit from a prior $41.8 billion and $9.89 per share. That is below the average $42.77 billion and $10.14 per share. He also cut Q4′s estimate to $33.5 billion and $7.16 per share from a prior $37.1 billion and $8.32 per share. That is below consensus for $39.78 billion and $9.41 per share.

Hargreaves trimmed his Q2 iPhone number to 36.9 million from 37.3 million, “largely related to the product cycle, which we consider to be a transitory issue.”

“However, we continue to believe sell-through evidence supports our view that the high end of the smartphone market is quickly becoming saturated.”

His main concern is the iPad: “We consider the reduction to our large-format iPad estimates to be the most significant, as this appears likely to be a sustained trend as tablet demand shifts to smaller and less expensive models.”

His iPad number goes to 16.5 million units for Q2 from a prior 17-million estimate. For Q3, he is number goes to 15 million from 18.5 million, “as we anticipate soft demand for large-format iPads and a demand pause in front of a likely fiscal Q4 product refresh.”

“We expect a Retina iPad Mini in FQ4,” adds Hargreaves, “but we do not know if it will replace the existing iPad Mini at the same price points, or if Apple will keep the iPad Mini as an entry-level product and replace the iPad 2.”

Hargreaves also comments in brief on rumors of a lower-priced iPhone, stating that he’s not been able to divine any evidence of component orders for the device, “which is somewhat unusual this close to the anticipated launch.”

One question is what a cheaper iPhone will do for Apple in the market:

In addition to the lack of clear component orders for a “low-cost” iPhone, it remains unclear whether the “low-cost” device is intended to open up the sub-$300 market, or if it is intended to expand share of the $300-plus market through a broader assortment of more fashion-oriented products. We believe Apple would maximize its long-term profit potential by continuing to focus on dominating the $300-plus market segment rather than moving significantly downstream.

Update: I neglected to mention earlier that Shebly Seyrafi of FBN Securities also cut estimates for Apple today, while reiterating an Outperform rating and a $650 price target.

Seyrafi cut his March-quarter iPhone estimate to 35.3 million from 37 million units, and cut his Q3 estimate to 30 million from 43 million. His estimate for the full fiscal year ending in September goes to $184.8 billion and $44.58 per share form a prior $198.2 billion and $47.82.

Seyrafi acknowledge stepped-up competition, but thinks Apple will prevail with new products later this year:

Clearly, the AAPL story has become more challenged lately due to increased competition from Samsung (which has more SKUs and more price points suitable for faster-growing emerging markets), concerns about innovation post-Steve Jobs, and concerns about whether the long-term GM is headed much lower (a la Nokia (NOK)). However, we see AAPL addressing the low-end iPhone concern in CH2 and the lack of a 5″ or higher iPhone concern in C2014. On the iPad front, we expect a new fifthgeneration iPad and and an iPad Mini with Retina Display this year, although the timing is more unclear. Meanwhile, we see the company starting to return more capital to shareholders in the form of higher dividends (we see dividends going from $10.60/yr. with a 2.3% dividend yield currently to ~$14/yr. with a 4.0% dividend yield) and possibly share buybacks as the company executes on its program to return $45B in capital to shareholders over three years (note that $10B of this has already occurred).

Seyrafi adds that he thinks the stock is cheap even if gross margin declines substantially going forward, as he expects it will:

We see AAPL’s gross margin (38.6% last quarter) declining steadily over the next many years due to increased competition from Samsung (pressuring AAPL’s highest gross margin segment – the iPhone), the introduction of low-end iPhones, more form factors/SKUs (increasing costs), and the possible introduction of an iTV (where we would model the GM at ~30%). Even so, as long as the GM does not decline below 33%, the stock is undervalued.

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